What fund managers expect in 2017

GLOBAL EQUITIES

Andrew Bell, chief executive officer, Witan Investment Trust (WTAN)

Equity markets are priced to give patient investors the benefits of global growth, but with no windfalls from valuations. A potentially more pro-growth tilt to economic policy could mean the equity bull market spills over to areas previously lagging behind, such as financial and industrial cyclicals and emerging economies.

Possible disruptions include Donald Trump’s presidency taking time to settle down, European politics and UK confidence worse hit than expected by Brexit negotiations. But there is potentially hope to be had from the shift towards more active fiscal policy easing and a gradual normalisation of interest rates, allowing assets to be priced by investors’ assessments of value/potential returns rather than central bank price-setting via quantitative easing (QE).

The willingness of governments to use low borrowing costs to fund increased spending commitments or tax cuts tilts the risks in favour of higher yields. A greater focus on spending your way to growth means bonds are vulnerable to greater supply and increased inflation risk.

Equities’ exposure to the fruits of growth could increase their relative attractions, although rising rates and high valuations in some areas are headwinds.

Significant overseas earnings in the UK market should present a tailwind to corporate earnings in 2017, available at lower ratings than in the US. If UK growth suffers, sterling could weaken further and intensify the profits boost. If the UK economy performs better than currently downgraded expectations, sterling could revive modestly, although not far given the Brexit uncertainties and the size of the current account deficit. But sentiment towards the UK market would improve.

In Japan, the stock market should enjoy a period of improving earnings estimates in 2017, if recent yen weakness is sustained.

Policy uncertainty over the Trump presidency and a tightening of dollar liquidity have cast a pall over emerging markets. But while risks remain, an apparent end to falling commodity prices, a possible pick-up in global growth and relatively low valuations present opportunities for longer-term investors.

James Thomson, Rathbone Global Opportunities Fund (GB00B7FQLN12)

Donald Trump could be the most pro-growth, pro-business, reflationary president in a generation. But the unpredictability of his policy announcements could make investment decisions even harder. And many of the areas currently seen as Trump beneficiaries, such as infrastructure plays, commodities, healthcare and banks, could disappoint if some of his most aggressive spending plans and regulatory relief are reined in by Republicans worried about a ballooning deficit.

Investors should embrace diversity and balance over the next year, rather than trying to pick hot areas. In a low-growth world, investors have become ever-more skittish. Portfolio performance is likely to be inconsistent, as investors will rotate in and out of industries that will be helped or harmed by Mr Trump’s attention. We saw this with the rapid reflation trade that boosted lower-quality cyclical companies in November. Following Mr Trump’s victory, investors were quick to sell companies that looked threatened by him and buy companies that would benefit from the fiscal splurge he is touting. Expect more of this short-term mentality in the months and years ahead.

Mark Whitehead, Securities Trust of Scotland (STS)

Donald Trump’s reflationary stance through favouring infrastructure and defence spending, and widening healthcare provision, while ultimately generating stronger gross domestic product (GDP) growth, may well underpin equities. And once he has formed his administration the policies enacted may turn out to be more moderate [than suggested during the election campaign].

For UK-based investors, a large proportion of the return from global equities since the Brexit vote has come from sterling weakness. The UK’s withdrawal from Europe is likely to be a drawn-out process and this will undoubtedly cause fluctuations in activity, not only at home but also in Europe. Add to this the risks inherent in the outcome of European elections, Greece requiring refinancing and rising geopolitical tensions between Russia and other western states, and we are reminded that the equity market may well be too complacent.

Investors are unlikely to remain as sanguine as they have been over the past few months and the lack of macroeconomic visibility will result in bouts of sharp equity market volatility.

We therefore continue to seek companies that offer a mixture of organic growth, high quality and attractive valuations. The credit analysis we employ should enable us to avoid companies with inappropriate balance-sheet leverage and liquidity for the business models they operate, which can lead to dividend cuts and capital volatility.

UK EQUITIES

Gervais Williams, manager of funds including Diverse Income Trust (DIVI)

The UK has stable political leadership and, although there are Brexit worries, these are offset to a certain extent by the devaluation of sterling.

To some degree the formal signature of Article 50, the process for triggering the UK’s departure from Europe, is already discounted by markets. However, the imminence of the event has slightly distracted investors from other risks in Europe. Social attitudes are changing, and therefore there is political capital for those espousing more nationalistic policies. This has the effect of increasing the faultlines within many international markets.

The prospects for the UK economy might not be sparkling; however, one of the advantages of the UK is that we have a vibrant market of smaller companies. The key attraction of these is that they are generally more agile, and importantly many are investing for productivity improvement at a time when overall productivity is flatlining. So the prospects for smaller companies are not that directly linked to the triggering of Article 50.

Sterling weakness should generally lead to more consumer inflation, but it seems likely that wages won’t keep up with inflation. So most investors are cautious on the consumer, as demand for bigger-ticket items might peak out.

But many UK companies competing against imports could benefit from the weakness of sterling. And those with overseas operations, especially those that export from the UK, could benefit.

The scope for reducing interest rates, the effectiveness of quantitative easing (QE) and the ability of governments to run a larger budget deficit are constrained. So the penalty for investing in a quoted company that gets into financial difficulty could be a lot more significant.

Investors need to select holdings for their promising prospects, but also put a lot more emphasis on selecting those with financial resilience.

Mark Barnett, manager of funds including Edinburgh Investment Trust (EDIN)

The UK equity market looks fully valued, inflated by the post-Brexit rally in international stocks and recovering commodity prices, particularly relative to the disappointing overall level of underlying profit growth recorded this year. So it’s highly unlikely the rerating of UK equities will continue unchecked, and there has been a noticeable pick-up in the rate of profit warnings across the market.

In 2017 several challenges may force a reassessment of UK equity market valuations, such as the lack of overall profit growth, which without the significant devaluation in sterling would have seen another year of no growth in 2016. The underlying earnings outlook for next year looks similarly muted, and a more difficult near-term UK economic picture may emerge.

Violent sector rotation since the vote for Brexit has thrown up opportunities and pockets of value for long-term investors in more domestically-focused sectors, including strongly positioned companies in retail, property and certain financials.

The most important discipline is to remain vigilant about valuation. Our emphasis will also continue to be on companies that demonstrate sustainable top-line growth and translate that into profit, free cash flow and dividends, and without excessive financial leverage.

By taking advantage of pricing anomalies in depressed areas of the market, alongside some profits from inflated dollar earners, I have increased my portfolios’ domestic exposure.

Few industries have been able to retain pricing power, but two sectors that have shown resilience in the past – pharmaceuticals and tobacco – continue to look well positioned to deliver future earnings and dividend growth. I have large positions in both sectors across my portfolios.

For the pharmaceuticals companies, ageing populations across the developed world provide a fundamental support to increasing volumes and continued innovation – a key driver of top-line growth. Political pressures with regard to the affordability of medicines, particularly in the US, have put the sector under some scrutiny, but innovation and competition have continued to support pricing power. The outcome of the US election may alleviate some of these pressures, while anticipated changes to US healthcare policy may present further growth opportunities.

Tobacco companies have shown resilience to declining sales volumes and performed strongly over the past two years, delivering both earnings and dividend growth.

British American Tobacco (BATS) has continued the drive towards consolidation in the sector with its recent bid for the 57.8 per cent of Reynolds American (RAI:NYQ) it doesn't already own. Such a deal would be earnings accretive for British American Tobacco, even assuming a likely increase in the offer price, and is the logical progression for both companies.

Neil Hermon, manager of Henderson Smaller Companies Investment Trust (HSL)

The main risks to equities include a faltering UK economy caused by uncertainty over the triggering of Article 50 and ongoing negotiations on the UK’s exit from the EU. The triggering of Article 50 could have a negative impact on consumer and corporate confidence. Although nothing is likely to change in the short term, uncertainty is never good for making major investment decisions, and is the main reason why forecasters expect a slowdown in UK growth in 2017.

However, the government and the Bank Of England are fully aware of this and stand prepared, either through fiscal or monetary policy, to intervene to protect the UK economy.

There is also the risk of rising inflation, particularly from imported goods, while consumers may be squeezed as net disposable income is under pressure from wage inflation, which doesn’t match cost of goods inflation. We are nervous on the outlook for the UK consumer, so are underweight in areas such as travel and leisure, and retailers.

But we have a diversified portfolio with around 50 per cent of the earnings coming from international markets. In an environment where the UK economy is struggling, this gives us protection – overseas earnings will be more valuable because of diversification and a likely weakening of sterling.

Many UK businesses look well placed to do well in the year ahead even if the UK economy slows. For example, Cineworld (CINE) makes 40 per cent of its earnings from emerging Europe and going to the cinema is a lower priced (and so less vulnerable) consumer purchase.

Midwich (MIDW) is benefiting from geographic expansion, a growing market and an excellent management team.

And Safestyle UK (SFE) is making market share gains, expanding geographically and has weak competition.

Merger and acquisition (M&A) activity should pick up in 2017 as the devaluation of sterling means UK corporates, especially ones with an international angle, are considerably cheaper for overseas companies. And there are high levels of cash in corporate coffers and low interest rates. Mid and small caps should benefit from this trend.

Over the past year we have been focusing on areas that show structural growth trends - companies that can grow independent of the economic cycle. This means we are overweight in areas such as healthcare via Clinigen (CLIN), which specialises in ethical drug supply and speciality pharmaceuticals; drug delivery device supplier Consort Medical (CSRT) and veterinary drug company Dechra (DPH).

We have also been adding stocks with undervalued structural growth such as Smart Metering Systems (SMS) and theme park technology provider Accesso Technology (ACSO).

Jamie Clark, co-manager, Liontrust Macro Equity Income Fund (GB00B888YP40)

Many investors are exposed to bond-proxy equities such as tobacco, consumer staples and utility companies, and are liable to suffer material capital losses as bond yields rise in anticipation of growth and incipient inflation. Assorted quality/bond proxy/expensive defensive businesses appear richly priced and vulnerable to a material derating should bond yields continue to rise.

While the pressure that rising rates will exert on bond-proxy equities is addressed in the fund’s zero-weighting to tobaccos, consumer staples and utilities; our defensive exposure via telecoms and pharmaceutical companies offers some protection by dint of relative valuation.

As the appetite for fiscal activism grows, we anticipate that 2017 will see excess returns accrue to UK cyclicals. Typically, such businesses exhibit value characteristics and have been deeply unfashionable in an era of unprecedented monetary accommodation.

We have initiated a fresh infrastructure/fiscal activism theme in expectation of a political bias to reflate and the attendant fillip to UK quoted cyclicals. The nascent and associated inflection in bond yields also augurs well for financials and our funds have a material weighting in UK life insurers.

Mid-cap banks and life insurers, some housebuilders, and UK construction firms offer opportunities.

EUROPE

John Bennett, manager of Henderson European Focus Trust (HEFT)

The key influences going into 2017 will be whether equities move from being a growth to value market on a global basis. It’s been a one-way growth market since the financial crisis. But we are running out of road on QE and that will shape markets. I therefore believe we have touched the lows on bond yields globally, and the valuation high-water mark for bond proxies – equities perceived to pay safe and predictable dividends that equate to higher yields than those offered by much of the bond market.

In October and November it became very uncomfortable to be in those stocks, and I think we are moving from a growth to a value market. The most important sector as we move into 2017 is something I have not liked for the past decade – financials.

Currency is important. If we get a strong dollar it is usually good for European equities. And if we’re moving from a growth to value market, this could knock on the head US equity outperformance versus other parts of the world. The value markets of the world are Europe and Japan, just by the nature of indices. So I think there might be an asset allocation shift to come.

However, the political upheavals that we’ve seen – Brexit and Trump – are moving now to Europe, and that will be a whole lot trickier as it’s not one nation, but a currency bloc. You could easily see the wobbles come back in the periphery in the form of the euro, and that political risk holds me from saying that, relative to the US, Europe is now a buy. But we will get through that political risk and that is what might create the opportunity to buy Europe.

Sam Morse, manager of Fidelity European Values (FEV)

Given high valuations, mounting political and social uncertainty, and a generally weak outlook for earnings growth, it is hard to be too bullish on the outlook for the market as a whole.

In this uncertain environment, I remain focused on building a balanced, diversified portfolio of robust companies that should be able to provide their shareholders with long-term dividend growth. These sorts of companies may appear more numerous in sectors such as consumer staples or healthcare than in sectors such as financials or energy.

However, I want the portfolio to have a diversified set of macroeconomic exposures, so a balanced and rounded approach to sector allocation is important, and I make a point of trying to find opportunities across the whole market.

There appears to be a growing recognition that monetary easing has achieved all it can – stabilisation of financial markets without a meaningful improvement in confidence. Hope now seems to be shifting towards a fiscal expansion, but room for manoeuvre is limited by high levels of government debt in southern Europe and customary caution in Germany.

In any case, the benefit of fiscal stimulus is questionable, as evidenced in Japan. Any fiscal expansion is unlikely to bring about a significant change in the long-term economic fundamentals in Europe.

Tim Stevenson, manager of Henderson EuroTrust (HNE)

Inflation remains subdued, but is rising and QE has its limits. Negative interest rates damage economies more than they help economies, and they prevent banks recovering. High-growth businesses should maintain a premium valuation to the market, but how much of a premium investors are willing to pay remains unclear.

Eurozone inflation should rise to nearer 2 per cent and 10-year bond yields are likely to increase. We know this will have an impact on how to value long-term growth stocks – they are unlikely to maintain as high a premium as they had in recent years – but we do not know how high bond yields will rise, although I suspect not much more before 2018. And in what is likely to remain a low-growth world we do not know what premium growth stocks will command.

But I think that Europe will finally see earnings growth come through, helped by better underlying demand, helpful currency effects and less fiscal austerity, and the possibility of more, albeit moderate, fiscal easing.

My highest-conviction positions are quality growth compounders that have been laggards in terms of share price, but not in earnings. In a world that has become more uncertain with Brexit and Trump, these companies have proved resilient in earnings and in many cases continued to grow, yet have seen their share prices and hence valuations decline. Reliability in a less reliable world, yet at a lower valuation level, is pretty compelling.

The possibility of intense political uncertainty may lead to renewed threats to the very existence of the euro. And in volatile times, consistent, reliable companies that increase the returns to shareholders tend to do better.

US

Angel Agudo, manager of Fidelity American Special Situations Fund (GB00B89ST706)

The US economy remains in good shape and should continue to improve at a moderate pace. Continued tightening in the labour market and the associated pick-up in wage growth mean consumption is expected to remain an important driver of growth. The strength of the services sector and improving activity in housing and construction-related sectors, should also support the economy.

From a fiscal, monetary, trade and legislative perspective, US President-elect Donald Trump has been widely viewed as someone who could bring unprecedented policy uncertainty. But irrespective of the initial market reaction, I do not think the outcome of the US presidential election dictates how markets will act in the long term.

Interest rates can only go higher in the near term; however the magnitude and pace will depend on upcoming economic data. Unsurprisingly, a lot of interest-rate-sensitive companies, primarily financials and banks, appear to have attractive valuations. Banks also seem to have the best balance sheets in decades and my portfolio has noteworthy positions in the sector.

However, I have not gone extensively overweight in this area as we are probably in the advanced stages of the economic cycle and there has been increased regulatory oversight on the sector. Credit quality also has the potential to worsen from its current pristine phase.

Almost all market participants agree that there is need for fiscal spending. Infrastructure spending as a percentage of GDP is near multi-decade lows and some of this potential recovery seems to have been discounted in the valuation for construction materials and other aggregate companies.

Defence is another area where government spending is most likely to increase. In particular, I am positive on short-cycle defence companies that typically provide comparatively smaller defence-related products and services.

But at aggregate levels margins are high and valuation multiples are not low. Moreover, growing wages and interest rate pressures, combined with the still strong US dollar, could weaken margins in some sectors.

Don San Jose, manager of JPMorgan US Smaller Companies Investment Trust (JUSC)

Since the US elections, small-caps have rallied as these seem best positioned to benefit from the president-elect’s pro-growth and business policies, such as a reduction in corporate and individual taxes, and regulatory reform, which could have a long-term positive effect on the US economy.

Small-caps tend to have more sensitivity to the domestic economy and a higher median tax rate. Better economic growth and lower taxes should be supportive of further small-cap outperformance, particularly if the US dollar continues to strengthen.

US equities should be able to deliver positive returns. Profits remain healthy and could possibly improve as headwinds from the strong US dollar and low energy prices moderate, the US consumer is in decent shape, and comparative values between equities and bonds remain favourable for equities.

US smaller companies include innovative businesses that serve market niches and can be a way to get in early on innovation. But there is a tendency for small-caps to underperform when volatility picks up. So we invest in high-quality companies that have sustainable competitive advantages, durable business models and solid management teams who have a track record of value creation. And we buy them at valuations we believe are below their intrinsic value and offer a margin of safety.

We target businesses we think can grow irrespective of the sector they come from. But we are seeing many opportunities in the consumer discretionary, producer durables, and materials and processing sectors to which we are most overweight relative to our benchmark.

Our portfolio is focused on US domestic growth and earnings which, by and large, are in reasonably good shape. Since the start of the year we have added more than 10 new names to the portfolio from across a spectrum of sectors, which returned to our radar due to their valuation. These had been cast aside as a result of volatility brought about by a variety of issues, including the presidential election campaign. These include medical device company ICU Medical (ICUI:NSQ),which has zero debt, a great balance sheet, strong cash flow credentials and develops mission-critical products with high barriers to entry.

JAPAN

Andrew Rose, manager of Schroder Tokyo (GB00BGP6BR86)

If the higher US interest rates and the stronger dollar that have prevailed since that country’s election are sustained, the Japanese equity market will be well supported by improved earnings expectations and extremely low long-term domestic bond yields.

The main risks to Japanese equities appear to be external. These could include appreciation of the currency, a sharp slowdown in global growth expectations or a rise in protectionism led by the new US administration.

With the current weaker trend in the yen we should see upwards revisions from large companies and exporters going into 2017. However, with recent economic data improving, we also remain comfortable with the scope for positive surprises from more domestically-focused companies as the Japanese economy slowly moves in the right direction.

The quick move up in bond yields globally since the US election has changed the outlook for many financial-related companies, including banks and insurance companies. Japanese yields have risen less than other markets as the Bank of Japan continues to buy bonds aggressively but, after a long period of underperformance, financial stocks may also have started to turn in Japan.

The current trends in currencies could provide a tailwind for the Bank of Japan’s efforts to pull the economy out of deflation. At the same time, the outlook for corporate profits is picking up, and a relatively low starting point for valuations gives us further confidence that earnings growth over the next couple of years can be reflected in a rerating of the market.

The portfolio retains a moderate pro-cyclical bias, and is underweight in some defensive areas of the market, such as food stocks, which we still feel are overvalued despite their recent underperformance.

ASIA ex JAPAN

Adrian Lim, manager of Edinburgh Dragon Trust (EDIN)

The US election result has introduced more uncertainty, which isn't good for emerging Asian stocks. The main risks to these are if the Federal Reserve raises US interest rates at a faster pace in anticipation of stronger inflation, Donald Trump follows through on his protectionist rhetoric or a shock result in national polls that could weaken the integrity of the EU.

But we like India: although stock prices have fallen recently, this is more a knee-jerk reaction to demonetisation than dismay over Mr Trump’s victory. Demonetisation has been hugely disruptive, but it shows that policymakers aren’t afraid of taking painful steps for long-term benefits. It’s been a very good year for progress on reforms, economic fundamentals have improved, local markets are not as exposed to global turmoil and Indian companies are among the best in the region.

However, it’s hard to see a major recovery for stocks in the Philippines. Foreign investors have pulled out money on concerns over President Rodrigo Duterte’s unorthodox leadership style, compounding existing fears that shares were overpriced. Trump-inspired anti-immigration and protectionism may even curb remittances from overseas and damage the business outsourcing industry.

Our overweight geographic positions relative to the benchmark include Singapore and Thailand. Overweight sectors include telecom services, real estate, and food and beverages.

EMERGING MARKETS

Nick Price, manager of Fidelity Emerging Markets Fund (GB00B9SMK778)

The Indian IT outsourcers to which we have exposure generate dollar revenues, and if a weaker dollar emerges that may drive some investor concerns. However, a reasonable amount of bad news is already in the price, with the market having treated these stocks with caution since the UK referendum in June. They remain attractive cash-generative businesses that are very capital-light. And as these stocks are trading at multi-year lows the probability of them suffering significant negative returns from here is low.

Last month the Indian government announced that 500 and 1,000 rupee notes would cease to be legal tender by the end of the year. While this has caused some short-term chaos, particularly in India’s thriving cash economy, it is further evidence of the government’s determination to enact bold economic reform. And this policy is likely to offer long-term benefits to some of India’s better-run banks as digital transaction volumes increase.

India also benefits from a huge and growing population and GDP growth of 7 to 8 per cent a year. Our favourite position is India’s largest private bank HDFC (HDFCBANK:NSI).

The company has taken a forward-looking approach towards digitising its back office and is growing its loan book at a rate of 20 per cent a year. Because it has already invested heavily in its infrastructure, it appears well positioned to reap the rewards of this growing loan book without being exposed to significant growth in overheads.

However, the Chinese government does its banks a disservice by continuing to drive their lending policies. As a consequence, many fundamentally flawed state-owned enterprises continue to receive bank loans despite the possibility they will be unable to service their debts in the future. A significant portion of Chinese loans could turn bad, and at some point China’s banks will almost certainly need to be recapitalised.

But China is a burgeoning consumer story. This once again became apparent on 11 November, [a celebration in China], which has turned into an online shopping event that dwarves Black Friday. Online retailer Alibaba (BABA:NYQ) alone saw $18bn-worth of sales, up from $14bn in 2015.

However some companies are clearly better placed to benefit than others, so our focus is on market leaders operating in underpenetrated areas with significant structural growth potential.

Rob Marshall-Lee and Sophia Whitbread, managers of Newton Global Emerging Markets Fund (GB00BVRZK937)

The outlook for emerging markets continues to be very differentiated with regard to individual countries, sectors and companies.

India’s trajectory is more internally-driven than some other emerging markets, with the government executing an impressive reform agenda, while exports represent only 12 per cent of GDP, and exports to the US less than 5 per cent of GDP.

US policy has a more limited effect on India’s fortunes, and the country’s significant improvement in its current account since the taper tantrum period of 2013 makes it more resilient in the face of rising bond yields globally.

Mexico’s position in the context of a Trump presidency has received close scrutiny, given his well-publicised dislike of the North American Free Trade Agreement (Nafta) and concerns about immigration. Given the very deep integration of US and Mexican manufacturing industries, it is hard to tell what the reality for Mexico and exporters like it will be, but early signs are that Trump is moderating his messaging already. Mr Trump is likely to be more pragmatic in government than was suggested by the rhetoric of his campaign.

In addition, we have seen some fairly sizeable price movements both before and after the election. This produces opportunities as prices of stocks and currencies are oversold due to prevailing negative sentiment.

Omar Negyal, manager of JPMorgan Global Emerging Markets Income Trust (JEMI)

Since the US election we’ve seen a quick adjustment in rates and currencies reflecting the view that US growth and inflation will be higher. That’s a challenge for emerging market equities, but the strength of emerging market domestic enterprises is still a compelling reason to invest.

Having retraced on recent good performance, fair value for emerging market equities is meaningfully above where it is today, if earnings growth can continue. If interest rates rise in an orderly fashion because of solid economic growth, emerging market equities could continue to perform.

The outlook for emerging markets remains difficult and there are still few signs of a true earnings recovery taking hold.

But some currencies are rising from their low levels and trade balances are improving. And volatile markets offer the opportunity to acquire stocks that the market has oversold over concerns around politics, the global economy and markets.

Taiwan has a robust dividend culture with a focus on cash dividends and minority investor-friendly dividend policies. The country’s dividend payout ratio is significantly above the emerging markets average at approximately 58 per cent.

We continue to look for stocks that generate attractive returns on equity, produce positive free cash flow, and have clear and understandable dividend policies. Even in an uncertain environment we are able to identify many stocks with attractive dividend yields, which bodes well for long-term returns.

We focus on companies we think have relatively more sustainable dividends and where there is scope for them to grow once the cycle improves. The portfolio has key overweights in Taiwan and South Africa, with Russia also overweight against MSCI Emerging Markets Index.